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The Honolulu Advertiser
Posted on: Monday, May 12, 2003

Hopes ride on consumers

By Will Edwards
Bloomberg News Service

ATLANTA — Back in December, Ken Hammock's home-improvement business was so slow, he worried that consumer spending was drying up and he wouldn't be able to pay his company's bills.

No longer.

In late January the orders started picking up. Today Hammock is so busy renovating kitchens and building decks in the Atlanta area that he is working 14-hour days.

"I can hardly catch my breath," he said.

Some economists, investors and Fed officials are saying it is too early to write off the consumer after household consumption in the first quarter grew at the slowest rate in a decade. The lowest interest rates in 41 years, gains in home equity and rising incomes, they argue, will fuel consumer spending even as the job market stagnates. Rising stock prices this year will only help.

"People who worry about the consumer being tapped out and unable to keep the expansion going are badly misinformed," said James F. Smith, director of the Kenan Institute's Center for Business Forecasting at the University of North Carolina. "There's plenty of fuel left on this side of the economy."

Smith was one of a handful of economists who accurately predicted economic growth would drop to 1 percent or less in 2001, when it contracted, according to the New York Times. Now he is predicting a 5 percent rise in personal consumption this year, more than twice as much as the 2.3 percent average of 53 forecasts in the April Blue Chip Economic Indicators survey.

Consumer spending accounts for 70 percent of gross domestic product, and purchases of cars and houses last year helped the economy expand as markets and manufacturing skidded. Economists including Kan-Êsas City Federal Reserve Bank President Thomas Hoenig warned that consumers would pull back after the slowest holiday retail growth in three decades.

Why the optimism now? Consumer sentiment has soared with the end of the war with Iraq. The New York-based Conference Board's consumer confidence index jumped to 81 in April from 61.4 the month before. In March, retail sales rose 2.1 percent, the largest increase since October 2001, and more recent anecdotal evidence shows continued strengthening, Smith said.

In April U.S. retailers' sales at stores open more than a year rose 3.2 percent. The Standard & Poor's 500 index has gained 15 percent since March 11, and crude oil prices have tumbled by about a third since Feb. 27.

Consumers' real support is coming from trends that carried them through the recession, economists say. Mortgage refinancings will probably total $1.55 trillion this year, up from $1.46 trillion, according to the Mortgage Bankers Association of America. Personal incomes in March were 3.6 percent higher than a year ago, the Commerce Department reported.

Those fundamentals will continue to underpin spending even as unemployment holds at an eight-year high, some economists say.

"Perhaps job growth is overrated," said James Paulsen, who oversees $110 billion as chief investment officer for Wells Capital Management in Minneapolis. "The consumer has enjoyed unique sources of stimulation in this cycle," which "will likely keep the consumer contributing to the recovery with or without new job creation."

Income rising at 'good pace'

Rising productivity is still making it possible for companies to boost wages, and tax relief passed in 2001 has helped households to keep more of the increases. According to Paulsen, disposable income — the money left after taxes — is growing at 7 percent a year, up from 2 percent at the end of 2001.

"Even though the job market is soft, consumer income has increased at a good pace," Fed Governor Ben Bernanke said in an April 24 speech in New York. "I expect the consumer to be a strong source of support to the economy and housing to continue to be strong."

Last year, consumers took $130 billion to $140 billion of equity out of their homes in cash-out refinancings, according to David Berson, chief economist for Fannie Mae, the No. 2 buyer of U.S. mortgages. In 2001, that figure was about $110 billion.

Hammock, the Atlanta contractor, tapped the equity in his home in January to keep his business going. His monthly gross sales dropped from $28,000 to just one-tenth of that in December. Hammock refinanced his home for the second time in 1 1/2 years to take out $22,000, enough to pay his company's bills.

"My wife and I talked a lot about it back then, and our feeling was that people were concerned about the economy, and instead of dumping money into their houses, they held on to it," he said. Orders started rebounding in late January, and now "confidence levels are back up again," Hammock said. His business will gross $500,000 this year, almost 50 percent more than last, he estimates.

With interest rates at four-decade lows, Fannie Mae's Berson says that three-quarters of fixed-rate mortgages are "in the money," meaning homeowners could refinance at current rates and reduce their payments.

The average rate on a 30-year fixed mortgage for Hawai'i fell last week to 5.4 percent, the lowest point in about 40 years.

Gaining room to spend

Federal Reserve statistics have shown that mortgage debt is rising while household net worth is dropping. According to the Fed's quarterly flow of funds report, home mortgages totaled $6.05 trillion in the fourth quarter of 2003, up from $5.39 trillion a year earlier. At the same time, household net worth — assets minus liabilities — fell 4.3 percent to $39.1 trillion.

That is one reason the Kansas City Fed's Hoenig in April listed retrenching consumer spending among the risks facing the economy. "Households are stretching as they have increased debt," Hoenig said. "Bankruptcy filings are at extraordinarily high levels."

In the same fourth-quarter Fed report, the total of home equity against which owners haven't borrowed jumped 5.8 percent to $7.59 trillion. This has enabled households to safely shoulder increased debt, the Kenan Institute's Smith maintains. The average equity in a home now exceeds $102,000, up from the 1989 record of $100,700, according to John Burns Real Estate Consulting, based in Irvine, Calif.

Consumers have also been paying down higher-cost debt, giving themselves room to spend more, said Lawrence Goodman, managing partner at Globaleqon LLC, a New York-based economic consulting firm. In an economy growing at 2 percent to 3 percent a year, nonmortgage consumer credit could rise by $5 billion to $6.5 billion a month and still keep debt in line with income, he estimated.

In March, the growth in consumer credit excluding mortgages slowed to $931 billion as auto borrowing declined, the Fed reported Wednesday. After increasing at an average of $12 billion a month in 2000, consumer borrowing has been gaining at $4.6 billion monthly in the past year.

Fed policy-makers voted last week to keep the overnight bank lending rate at a 41-year low. Fed funds futures contracts suggest traders expect the Fed to lower borrowing costs at its June 25 meeting. And Fed Chairman Alan Greenspan says there is no sign that housing values have risen too much.